Conditional volatility nexus between stock markets and macroeconomic variables: Empirical evidence of G-7 countries

The purpose of this paper is to analyse the relation between stock market volatility and macroeconomic fundamentals for G-7 countries using monthly data over the period from July 1985 to June 2015.

The empirical methodology is based on two steps: in the first step, the authors obtain the conditional volatilities of stock market returns and macroeconomic variables through the GARCH family of models. The authors also incorporate the impact of early 2000s dotcom and the global financial crises. In the second step, the authors estimate multivariate vector autoregressive model to analyze the dynamic relation between stock markets return and macroeconomic variables.

The overall results for G-7 countries indicate a weak volatility transmission from macroeconomic factors to stock market volatility at individual level but the collective impact of volatility transmission is highly significant. Although, the results of block exogeneity indicate a bidirectional causality except UK, but the causal linkage is quite weak from stock market to macroeconomic variables. Moreover, the local financial variables excluding interest rate are closely integrated, and the volatility of industrial production growth and oil price are identified as the most significant macroeconomic factors that could possibly influence the directions of stock markets.

This research establishes the nature of the links between stock market and macroeconomic volatility. Research to date has been unable to satisfactorily establish the empirical nature of such links. The authors believe this paper begins to do this.